Refinance Before a Divorce? See the Pros and Cons
If you’re looking to refinance your mortgage after a divorce in order to remove a spouse from the loan, it can be tricky but not impossible.
Divorce is stressful, painful and can get messy, especially when you and your spouse need to work through the logistics of dividing assets. Your home is likely the most valuable asset you and your spouse bought together, so you’ll need to decide whether you want to sell the house and split the profits, or if one of you will buy the other out. If you choose the latter, you may be wondering whether it’s in your best interest to refinance before or after the divorce.
Many divorcing homeowners mistakenly believe that they can have a former spouse’s name taken off the mortgage if the divorce decree awards the family home (and thus the mortgage) to one spouse. But a divorce decree doesn’t have the power to nullify your mortgage contract.
To remove a former spouse from the mortgage, you typically need to refinance the mortgage with the spouse who will keep possession of the home as the sole borrower. But that can be difficult to do after a divorce. In this guide, we’ll explain how it can work.
How divorce impacts your ability to refinance
Your credit score can have a huge impact on your ability to refinance and the interest rate you’ll receive when you do. Unfortunately, a divorce can have an adverse impact on your credit score.
While the divorce proceedings themselves don’t directly affect your credit score, other circumstances surrounding the divorce can lower your score.
- When you were married, the debt-to-income (DTI) ratio lenders used to make credit decisions took into account the salaries of both you and your spouse. Taking your former spouse’s income out of that equation could raise your DTI ratio and make it difficult to qualify for a refi.
- You may be required to close joint credit accounts, thus lowering your total available credit and raising your credit utilization rate.
- If your former spouse is unwilling or unable to pay balances due on joint accounts, delinquent payments may negatively impact your credit score.
- A vindictive spouse may make large purchases on joint accounts to intentionally rack up debt and damage the other’s credit history.
- You may miss payments on credit accounts because you are preoccupied with the divorce.
- If all financial accounts were in your ex-spouse’s name, you might have a limited credit history.
Reasons you SHOULD consider refinancing before a divorce
According to James Bogatay, a divorce lawyer with Pittsburgh Divorce & Familiy Law, LLC in Pittsburgh, Penn., there are pros and cons whichever way you go.
Here are some benefits of refinancing a house before a divorce:
You’ll have a better chance of qualifying
Couples typically “qualify for a mortgage better as a couple, especially in a dual-income household, than either party would individually,” Bogatay told LendingTree.
This often comes down to the debt-to-income ratio mentioned above. Your DTI ratio is calculated by dividing all of your monthly debt payments by your gross monthly income. Lenders use this ratio to measure your ability to manage your monthly debt payments. Most lenders want to see a DTI ratio of 43% or less.
For example, say Mike and Leah earn gross monthly incomes of $5,000 each, for a combined monthly gross income of $10,000. Their mortgage payment is $2,000 per month, and they have other debt payments totaling $1,000 per month, which they’ll split 50/50 after the divorce.
Pre-divorce, their DTI is 30%.
But if Leah wanted to keep the house after the divorce, assuming her monthly mortgage payment would remain at $2,000 per month, her DTI ratio would be 50% ($2,000 mortgage + $500 other debt payments / $5,000 gross income = 50%). If Leah waits until after they’re divorced to refinance the mortgage, she might have trouble getting approved with a DTI that high.
You’ll be able to establish the true value of the home
When you divide assets with your spouse, it’s helpful to know exactly how much your home is worth. Bogatay said refinancing can be beneficial because the appraisal often required as a part of the refinance process can give you an accurate valuation of your home.
You could lock in a lower interest rate
Mortgage rates are on the rise these days. Freddie Mac forecasts rates creeping up to around 5.1 percent by 2019. That may not seem like much, but even a small rate hike could mean thousands of dollars more in interest payments over the course of a 30-year mortgage.
To illustrate, say Mike and Leah are weighing the decision to refinance now versus waiting until after the divorce is finalized, which they anticipate happening sometime next year. We’ll assume that they can qualify for the average rate on a 30-year loan mentioned above.
|Refinancing and Divorce|
|Refinance Now||Refinance Next Year|
|Total interest paid||$264,681.70||$286,385.89|
If interest rates rise as predicted, waiting a year to refinance could cost an extra $21,704.19 in interest over the course of a 30-year mortgage.
You can make an educated decision to keep or sell the home
In some cases, one spouse wants to keep the family home, even though it’s not the wisest financial decision. In this case, determining what your monthly payment would be after the refi may be a good idea.
That process can give both parties an accurate look at how expensive the payments would be for whoever keeps the house. “The party that does keep the house when the assets are divided may not be able to afford to pay for the house on their own,” Bogatay said.
Realizing you aren’t prepared to take on the financial burden of the mortgage on your own and deciding to sell the property before finalizing a refinance could save a lot of time and expense later on.
“Sometimes, the finances work out such that the only way to remove both parties from the mortgage is to sell,” Bogatay said.
Reasons you should NOT refinance before a divorce
Despite the above arguments in favor of financing before a divorce, Bogatay said there are more cons to refinancing before a divorce than there are pros.
Your ex-spouse may still be on the mortgage
The biggest issue with refinancing before a divorce is that, in order to take advantage of a higher DTI ratio with your spouse, you’ll have to recommit BOTH spouses’ names to the title of the home and the mortgage, even though only one will continue living in the home and making the mortgage payments.
“Because of this, it usually necessitates another refinance after the divorce as well,” Bogatay said, “but sometimes one person can’t refinance by themselves, so an ex-spouse is
liable for the mortgage for years after the divorce.”
Your ex continues to have a role in your financial decisions
When you make the decision to divorce, you’re probably ready to start making financial decisions on your own. If you refinance with both names on the mortgage before your divorce because you won’t be able to qualify on your own after, your ex will continue to be a part of your finances.
“Allowing your soon-to-be ex-partner to continue to have a role in your financial decisions seems an odd choice and could lead to some future bitterness if either party becomes unhappy with the financial obligations from refinancing,” Bogatay said.
Refinancing comes at a cost
When you refinance your mortgage, you’ll pay closing costs, which can add up to thousands of dollars. Even if you choose a “no cost” refinancing, there are costs involved. “No cost” just means the lender will cover closing costs by adding them to your new loan balance or charging a higher interest rate.
So when you refinance before a divorce, Bogatay said you’re taking on more upfront costs in order to benefit more in the long run. “Only one party will reap the benefits of refinancing,” he said.
If you’re the one keeping the house, you might like the idea of having closing costs paid from joint assets. If your ex is the one holding on to the house, refinancing before your divorce isn’t as appealing.
Get the liquidity to buy your ex-spouse out
If you have quite a bit of equity in your home, your divorce decree may require the spouse keep the house to buy out the other’s half of that equity.
For example, if Mike and Leah own a home worth $400,000 and a mortgage balance of $300,000, each spouse is entitled to half of the $100,000 of equity, or $50,000.
If Leah plans on keeping the home and doesn’t have $50,000 in cash or other assets to buy out Mike’s share, a cash-out refinance may be the only way to liquidate Mike’s portion of the equity without selling the home.
Whether your decision comes down on the “pro” or “con” side of refinancing before your divorce depends on the individual circumstances of your finances, the value of your home, the interest rate you’ll be able to get and your relationship with your soon-to-be ex-spouse. Your best course of action is for both of you to talk to a lawyer or mortgage professional who can help you weigh your options.